Risk management: position sizing, leverage, liquidation, and drawdown
Covering how to size a position with a numeric example, the maths of recovering from drawdown, invalid assumptions, and a pre-trade risk checklist.
Risk management is the discipline of managing loss, not gain. The core is simple: on every trade you risk a small, fixed percentage of your account, and your position size is set by that risk and your stop distance. The goal is to survive, because the trader who protects the account is the one who can wait for opportunities.
Why it matters
Many people start with “how much will I make,” but the right question is “how much am I willing to lose.” Recovering from a drawdown gets disproportionately harder as the loss grows, so preventing large losses upfront is far easier than clawing them back later.
Position-size calculation
- Account
- Your total trading capital.
- Risk%
- The share you risk on a single trade (e.g. 1%).
- Stop distance
- The per-unit loss between entry and stop.
A numeric example
| Account | 10,000 units |
|---|---|
| Risk per trade | 1% = 100 units |
| Entry | 50.00 |
| Stop | 48.00 (distance 2.00) |
| Position size | 100 ÷ 2.00 = 50 units |
If the stop triggers, the loss is 100 units — 1% of the account. You sized the position by the risk you accept, not by gut feeling.
The maths of recovering from drawdown
| Gain needed to break even | |
|---|---|
| −10% drawdown | +11% |
| −25% drawdown | +33% |
| −50% drawdown | +100% |
| −75% drawdown | +300% |
Invalid assumptions
| “A high win rate guarantees profit.” | A few big losses can erase many small wins; what matters is the size of wins versus losses. |
| “I’ll size up to win the loss back.” | Adding to a loser (martingale) compounds risk and is the fastest way to blow up an account. |
| “If I don’t set a stop, the loss isn’t real.” | A stopless position only defers the loss without limit; an unrealised loss does not vanish, it grows. |
Pre-trade risk checklist
- Risk per trade is defined and small (e.g. 1%).
- The stop level and invalidation point are written before entry.
- Position size is computed with the risk/stop formula.
- A daily and total maximum-loss limit is defined.
- If using leverage, the liquidation distance is known.
No risk method removes losses; it only limits their size. Regulators remind traders that, especially with leverage, the entire capital can be lost.
Once risk is reduced to numbers, the next step is to ground entry and exit decisions in evidence. Move on to technical analysis.